54 property
Availability of debt for a changing landscape
In the very distant days of abundant liquidity, owners of real estate were able to access a plentiful supply of low-cost debt for real estate. Banks were increasing their lending to the sector at a tremendous rate, writes Mark Stuckey, head of real estate (southern), Barclays
The value of gross lending on UK real estate rose more than five-fold between 1999 and 2007. Furthermore the introduction of loans distribution through securitisation and other capital market sources added liquidity. Less than five years later the landscape appears to have changed fundamentally and falling property values, over exposure of key senior lenders and regulatory pressures have all contributed to constraints on the banks’ ability to lend.
How things have changed
Previously a bank would allocate capital to the loan based on the apparent riskiness and take into account the length of the loan. During the life of the loan the underlying assets might be re-valued – typically on an annual basis – which in the good times would have seen asset values rise and the riskiness of the loan decline further. Therefore the bank might have been able to reduce the capital allocated to the loan further during the life of the loan. In many instances the loans were repaying (or being refinanced) well before the maturity of the loan which helped persuade banks that the amount of capital being held was appropriate. Impairments were at a low level and on a seemingly declining trend.
Today, banks’ cost of funding has leapt dramatically. The five years credit default swap (CDS) spread for many large banks is now over 150bps meaning that a good portion of the margin that banks are charging no longer goes to contribute to the return the bank is making but simply helps it source the relevant funding for the transaction.
The amount of capital in the form of risk weighted assets (RWAs) that a bank holds against any one real estate loan has been increasing due to regulatory pressures, the increased loss experience of banks in the sector and a broader credit deterioration across loan books (with valuations under pressure and the prospects of repayment/ refinancing dwindling, banks are reassessing existing positions).
Capital markets are supporting the larger companies …
Despite all these changes, some sources of finance are still available and can be very attractive in today’s low interest rate
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environment. For the largest companies, a number of capital markets instruments can be attractive. The number of issues and volume of issuance for real estate companies has started to recover. This has been most notable in the corporate bond market and particularly for US private placements (USPP) which have established themselves as a viable funding tool. Investors in USPPs have a fondness for companies which are governed by a REIT status and subject to the restrictions this tends to place on companies, however, they are looking beyond these to alternative real estate assets such as student accommodation as well. USPPs can be attractive as they offer a combination of availability, access to longer tenors and (unlike corporate bonds) don’t require a public rating.
This investor base provides a great opportunity for real estate owners to partner with long-term capital providers who can act as a complementary source of finance alongside banks and the capital markets
For listed companies convertible bonds can be a flexible product which offers investors both the security of coupons and potential equity upside. The ability rapidly to access the market often where the conversion price is above current net asset value (NAV) and coupons are low provide a strong incentive to issue such instruments.
… and institutional debt investors are the big new players
Of particular interest to real estate companies at the moment is the growing appetite for real estate finance demonstrated by institutional investors such as insurance companies and pension funds. Many of these institutions have a long history of investing in real estate both directly and indirectly (through listed companies or real estate funds) and therefore have an appreciation of the sector.
As these investors are typically looking for relatively long term, stable and low risk returns, the real estate debt asset class has become attractive particularly given the elevated pricing level currently achievable and certain regulatory treatments. While a small number of players have been active in this field for a while, the current field of parties either actively lending or establishing capabilities to do so is in excess of 20. This investor base provides a great opportunity for real estate owners to partner with long- term capital providers who can act as a complementary source of finance alongside banks and the capital markets.
Flexible approach is key
The current challenging market conditions around bank finance for real estate will likely continue for some time as legacy loan books, regulatory uncertainty and challenging occupier markets all take their toll. Against this backdrop however, the introduction of new entrants and reintroduction of old entrants to the market means that real estate continues to remain fundable. A combination of proactive early engagement, a willingness to approach funding solutions in a flexible way and a diversified funding base will be key for all owners of real estate.
Details: Mark Stuckey 07827-807751
mark.stuckey@
barclays.com
THE BUSINESS MAGAZINE – THAMES VALLEY – MAY 2012
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